Economy and Regulatory requirements for BOI 2014 BANKdynamics

The video introductions to BANKdynamics mention the simulation environment (the economy) as having some growth potential. They also mention there will be some additional regulatory requirements in place.

The Economy At around the 8:15 mark in the video introduction I mention the market interest rate environment in which you will be playing. If you haven’t already watched the video you might want to view this one part. It’s a guaranteed “can’t miss” forecast of rates for the simulation next week. I’d hate for you to be in the dark.

Regulatory Capital Requirements In additional to setting and targeting your own team’s performance goals your bank has to meet the following regulatory requirements:

By the end of the 8 quarters of simulation your bank must have a Risk-Based Capital (RBC) ratio of at least 11.00%. You may recall that the Maverick Bank you inherited has an RBC of just below 10.00%. In BANKdynamics you can manage RBC in several ways.

You can issue new capital. Under the “Bank Capital & Reserves” section of your assumption form you can issue new common stock. We’re going to limit you to only one new issue of $10M (if you want it). You can make this new issue in any one of the 8 quarters of simulation. You should probably run a few WIFs to see the impact. .

You can change your asset mix. Different asset categories have different risk weightings – which means they have different capital requirements. A bank heavily invested in securities will have a higher RBC level than a similar sized bank with a higher concentration in loans. In general loans tend to be riskier than securities so the regulatory capital requirements are higher. .

You can earn enough net income. When the bank earns a profit you’ve got two fundamental choices – pay the profits out as dividends to your shareholders, or keep the money in retained earnings (i.e. capital). By making the appropriate decisions your bank could earn enough to increase your capital level and meet the regulatory requirement. .

You can monitor your RBC levels by looking at the last line of the Key Financial Ratios, Page 1 (Periodic or Comparative) report.

Managing Credit Quality By the end of the 8 quarters of simulation your bank’s Allowance for Loan & Lease Losses (ALLL) of at least 0.75% and your ALLL must be two times the size of your non-performers. The regulators are asking you to prepare for a potential credit quality problem – like a steady increase in non-performers, and falling collateral values (sound familiar?). This is sometimes referred to as “coverage” – does your ALLL “cover” your non-performers? In BANKdynamics you can manage your ALLL and non-performer levels in several ways:

Increase your quarterly provision expense to boost your ALLL. .

Recognize a certain portion of your non-performers as “bad loans” and charge-them-off. This will reduce your level of non-performers, but it will also reduce your ALLL or cushion – and you will have to replenish it (see prior point #1). .

Control your loan pricing. Charging higher spreads to Prime rate will tend to increase your interest income but it will also increase your risk. Higher loan rates at your bank may tend to push the better credit to other banks with lower rates leaving you with potential customers that have lower credit ratings. You have to manage the trade-off. .

Control your total loan portfolio growth. There is usually some correlation between rate of portfolio growth and the credit problems you experience. Sometimes the correlation is strong (higher growth means more credit problems), sometimes it’s not. This can be impacted by the next item (#5). .

Hire or fire people in the Loan Department. This is always a popular decision to try in the simulation because we’re not talking about “real-world” jobs. It also sometimes gives students a power-rush. Adding loan staff and raising their salaries tends to limit your credit quality problems. Firing people, or lowering their salaries (or both!) tends to exacerbate credit quality problems. .

You can monitor your projected coverage by looking at the Key Financial Ratios, Page 1, the top two lines under Asset Quality.

It will impact your overall score Remember that you’ll be receiving points out of 1000 as your final grade. While obtaining your goals is a big part of that score (the biggest part actually – 30%), we will take away points if you don’t meet these regulatory requirements. So just to be clear: points will be deducted from your final score if RBC is below 11.00%. Additional points will be deducted if your ALLL is not at least 0.75% and two times your non-performers!